nep-cba New Economics Papers
on Central Banking
Issue of 2006‒07‒09
forty papers chosen by
Alexander Mihailov
University of Essex

  1. Adaptive Learning, Endogenous Inattention, and Changes in Monetary Policy By Wiliam Branch; John Carlson; George W. Evans; Bruce McGough
  2. Evaluating Inflation Targeting Using a Macroeconometric Model By Ray C. Fair
  3. Inflation targeting under imperfect knowledge By Athanasios Orphanides; John C. Williams
  4. Monetary policy, determinacy, and learnability in a two-block world economy By James B. Bullard; Eric Schaling
  5. Why Has U.S. Inflation Become Harder to Forecast? By James H. Stock; Mark W. Watson
  6. Inflation risk and optimal monetary policy By William T. Gavin; Benjamin D. Keen; Michael R. Pakko
  7. Worldwide macroeconomic stability and monetary policy rules By James B. Bullard; Aarti Singh
  8. Optimal Currency Shares in International Reserves: The Impact of the Euro and the Prospects for the Dollar By Elias Papaioannou; Richard Portes; Gregorios Siourounis
  9. Nontraded goods, market segmentation, and exchange rates. By Michael Dotsey; Margarida Duarte
  10. Inflation as a Redistribution Shock: Effects on Aggregates and Welfare By Matthias Doepke; Martin Schneider
  11. The Macroeconomist as Scientist and Engineer By N. Gregory Mankiw
  12. Imperfect knowledge, adaptive learning and the bias against activist monetary policies By Alberto Locarno
  13. Can the U.S. monetary policy fall (again) in an expectation trap? By Roc Armenter; Martin Bodenstein
  14. Optimal Monetary Policy with Real-time Signal Extraction from the Bond Market By Kristoffer Nimark
  15. Monetary policy implementation without averaging or rate corridors By William Whitesell
  16. Launching the NEUQ: The New European Union Quarterly Model, A Small Model of the Euro Area and U.K. Economies By Anna Piretti; Charles St-Arnaud
  17. Optimal Stationary Monetary and Fiscal Policy under Nominal Rigidity By Michal Horvath
  18. Targeting inflation and the fiscal balance : what is the optimal policy mix? By Marcela Meirelles Aurelio
  19. Revisiting the empirical evidence on firms’ money demand By Francesca Lotti; Juri Marcucci
  20. How Well Does a Small Structural Model with Sticky Prices and Wages Fit Postwar U.S. Data? By Julien Matheron; Céline Poilly
  21. Implicit Bands in the Yen/Dollar Exchange Rate By Francisco Ledesma-Rodríguez; Manuel Navarro-Ibáñez; Jorge Pérez-Rodríguez; Simón Sosvilla-Rivero
  22. Estimating the New Keynesian Phillips Curve: a vertical production chain approach By Adam Hale Shapiro
  23. Forecasting of small macroeconomic VARs in the presence of instabilities By Todd E. Clark; Michael W. McCracken
  24. Efficient expropriation: sustainable fiscal policy in a small open economy By Mark Aguiar; Manuel Amador; Gita Gopinath
  25. Assessing Structural VARs By Lawrence J. Christiano; Martin Eichenbaum; Robert Vigfusson
  26. A Multinomial Approach to Early Warning Systems for Debt Crises By Alessio Ciarlone; Giorgio Trebeschi
  27. Banking on the principles : compliance with Basel Core Principles and bank soundness By Tressel, Thierry; Detragiache, Enrica; Demirguc-Kunt, Asli
  28. Exchange-rate effects on China’s trade: an interim report By Jaime Marquez; John W. Schindler
  29. How will China ' s saving-investment balance evolve ? By Kuijs, Louis
  30. Separation of Powers and the Budget Process By Gene M. Grossman; Elhanan Helpman
  31. On the General Relativity of Fiscal Language By Laurence J. Kotlikoff; Jerry Green
  32. Macroeconomic and financial stability challenges for acceding and candidate countries By Adalbert Winkler; Roland Beck
  33. Les mouvements cycliques du taux de change et les prix dans les secteurs canadien et américain de la fabrication By Baldwin, John R.; Yan, Beiling
  34. Exchange Rate Cycles and Canada- U.S. Manufacturing Prices By Baldwin, John R.; Yan, Beiling
  35. Finland's First 10 Years in the European Union - Economic Consequences By Jaakko Kiander; Antti Romppanen
  36. EU-Enlargement and Beyond: A Simulation Study on EU and Russia Integration By Pekka Sulamaa; Mika Widgrén
  37. Liquidity Insurance in a Financially Dollarized Economy By Eduardo Levy Yeyati
  38. National income accounts. By Leonard I. Nakamura
  39. Solving linear rational expectations models: a horse race By Gary S. Anderson
  40. Home production By Yongsung Chang; Andreas Hornstein

  1. By: Wiliam Branch (University of Californis - Irvine); John Carlson (Federal Reserve Bank of Cleveland); George W. Evans (University of Oregon Economics Department); Bruce McGough (Oregon State University)
    Abstract: This paper develops an adaptive learning formulation of an extension to the Ball, Mankiw and Reis (2005) sticky information model that incorporates endogenous inattention. We show that, following an exogenous increase in the policymaker's preferences for price vs. output stability, the learning process can converge to a new equilibrium in which both output and price volatility are lower.
    Keywords: expectations, optimal monetary policy, bounded rationality, economic stability, adaptive learning.
    JEL: E52 E31 D83 D84
    Date: 2006–06–22
  2. By: Ray C. Fair
    Abstract: Inflation targeting is evaluated in this paper using a structurally estimated macroeconometric model, denoted the MC model. This model differs substantially from the New Keynesian (NK) model, which is currently the workhorse macro model in the literature. Section 2 compares the two models and argues that the NK model is unlikely to be a good approximation of the economy and that one of its key features regarding the effects of monetary policy on the economy seems wrong. Section 3 then examines inflation targeting using the MC model. Various interest rate rules are tried with differing weights on inflation and output, and various optimal control problems are solved using differing weights on inflation and output targets. Price-level targeting is also considered. The results show that 1) there are output costs to inflation targeting, especially for price shocks, 2) price-level targeting is dominated by inflation targeting, 3) the estimated interest rate rule of the Fed (in Table 3) is consistent with the Fed placing equal weights on inflation and unemployment in a loss function, 4) the estimated interest rate rule does a fairly good job at lowering variability, and 5) considerable economic variability is left after the Fed has done its best. Overall, the results suggest that the Fed should continue to behave as it has in the past and not switch to inflation targeting.
    Keywords: Inflation targeting, Interest rate rules, Optimal control
    JEL: E52
    Date: 2006–06
  3. By: Athanasios Orphanides; John C. Williams
    Abstract: A central tenet of inflation targeting is that establishing and maintaining well-anchored inflation expectations are essential. In this paper, we reexamine the role of key elements of the inflation targeting framework towards this end, in the context of an economy where economic agents have an imperfect understanding of the macroeconomic landscape within which the public forms expectations and policymakers must formulate and implement monetary policy. Using an estimated model of the U.S. economy, we show that monetary policy rules that would perform well under the assumption of rational expectations can perform very poorly when we introduce imperfect knowledge. We then examine the performance of an easily implemented policy rule that incorporates three key characteristics of inflation targeting: transparency, commitment to maintaining price stability, and close monitoring of inflation expectations, and find that all three play an important role in assuring its success. Our analysis suggests that simple difference rules in the spirit of Knut Wicksell excel at tethering inflation expectations to the central bank's goal and in so doing achieve superior stabilization of inflation and economic activity in an environment of imperfect knowledge.
    Date: 2006
  4. By: James B. Bullard; Eric Schaling
    Abstract: We study how determinacy and learnability of worldwide rational expectations equilibrium may be affected by monetary policy in a simple, two country, New Keynesian framework under both fixed and flexible exchange rates. We find that open economy considerations may alter conditions for determinacy and learnability relative to closed economy analyses, and that new concerns can arise in the analysis of classic topics such as the desirability of exchange rate targeting and monetary policy cooperation.
    Keywords: Monetary policy ; Foreign exchange
    Date: 2006
  5. By: James H. Stock; Mark W. Watson
    Abstract: Forecasts of the rate of price inflation play a central role in the formulation of monetary policy, and forecasting inflation is a key job for economists at the Federal Reserve Board. This paper examines whether this job has become harder and, to the extent that it has, what changes in the inflation process have made it so. The main finding is that the univariate inflation process is well described by an unobserved component trend-cycle model with stochastic volatility or, equivalently, an integrated moving average process with time-varying parameters; this model explains a variety of recent univariate inflation forecasting puzzles. It appears currently to be difficult for multivariate forecasts to improve on forecasts made using this time-varying univariate model.
    JEL: C53 E37
    Date: 2006–06
  6. By: William T. Gavin; Benjamin D. Keen; Michael R. Pakko
    Abstract: This paper shows that the optimal monetary policies recommended by New Keynesian models still imply a large amount of inflation risk. We calculate the term structure of inflation uncertainty in New Keynesian models when the monetary authority adopts the optimal policy*the policy that minimizes the gap between output in the New Keynesian model and output in a flexible wage and price model. When the monetary policy rules are modified to include a small weight on a price path, the economy achieves equilibria with substantially lower long-run inflation risk. With sticky prices, the price path target reduces long-run inflation uncertainty with no measurable increase in the variability of the output gap. With sticky wages, a tradeoff exists between short-run output stabilization and long-run inflation risk.
    Keywords: Monetary policy ; Inflation (Finance)
    Date: 2006
  7. By: James B. Bullard; Aarti Singh
    Abstract: We study the interaction of multiple large economies in dynamic stochastic general equilibrium. Each economy has a monetary policymaker that attempts to control the economy through the use of a linear nominal interest rate feedback rule. We show how the determinacy of worldwide equilibrium depends on the joint behavior of policymakers worldwide. We also show how indeterminacy exposes all economies to endogenous volatility, even ones where monetary policy may be judged appropriate from a closed economy perspective. We construct and discuss two quantitative cases. In the 1970s, worldwide equilibrium was characterized by a two-dimensional indeterminacy, despite U.S. adherence to a version of the Taylor principle. In the last 15 years, worldwide equilibrium was still characterized by a one-dimensional indeterminacy, leaving all economies exposed to endogenous volatility. Our analysis provides a rationale for a type of international policy coordination, and the gains to coordination in the sense of avoiding indeterminacy may be large.
    Keywords: Keynesian economics ; Monetary policy ; Inflation (Finance)
    Date: 2006
  8. By: Elias Papaioannou; Richard Portes; Gregorios Siourounis
    Abstract: Foreign exchange reserve accumulation has risen dramatically in recent years. The introduction of the euro, greater liquidity in other major currencies, and the rising current account deficits and external debt of the United States have increased the pressure on central banks to diversify away from the US dollar. A major portfolio shift would significantly affect exchange rates and the status of the dollar as the dominant international currency. We develop a dynamic mean-variance optimization framework with portfolio rebalancing costs to estimate optimal portfolio weights among the main international currencies. Making various assumptions on expected currency returns and the variance-covariance structure, we assess how the euro has changed this allocation. We then perform simulations for the optimal currency allocations of four large emerging market countries (Brazil, Russia, India and China), adding constraints that reflect a central bank’s desire to hold a sizable portion of its portfolio in the currencies of its peg, its foreign debt and its international trade. Our main results are: (i) The optimizer can match the large share of the US dollar in reserves, when the dollar is the reference (risk-free) currency. (ii) The optimum portfolios show a much lower weight for the euro than is observed. This suggests that the euro may already enjoy an enhanced role as an international reserve currency ("punching above its weight"). (iii) Growth in issuance of euro-denominated securities, a rise in euro zone trade with key emerging markets, and increased use of the euro as a currency peg, would all work towards raising the optimal euro shares, with the last factor being quantitatively the most important.
    JEL: F02 F30 G11 G15
    Date: 2006–06
  9. By: Michael Dotsey; Margarida Duarte
    Abstract: Empirical evidence suggests that movements in international relative prices (such as the real exchange rate) are large and persistent. Nontraded goods, both in the form of final consumption goods and as an input into the production of final tradable goods, are an important aspect behind international relative price movements. In this paper we show that nontraded goods have important implications for exchange rate behavior, even though fluctuations in the relative price of nontraded goods account for a relatively small fraction of real exchange rate movements. In our quantitative study nontraded goods magnify the volatility of exchange rates when compared to the model without nontraded goods. Cross-country correlations and the correlation of exchange rates with other macro variables are closer in line with the data. In addition, contrary to a large literature, standard alternative assumptions about the currency in which firms price their goods are virtually inconsequential for the properties of aggregate variables in our model, other than the terms of trade.
    Keywords: Markets ; Foreign exchange rates
    Date: 2006
  10. By: Matthias Doepke; Martin Schneider
    Abstract: Episodes of unanticipated inflation reduce the real value of nominal claims and thus redistribute wealth from lenders to borrowers. In this study, we consider redistribution as a channel for aggregate and welfare effects of inflation. We model an inflation episode as an unanticipated shock to the wealth distribution in a quantitative overlapping-generations model of the U.S. economy. While the redistribution shock is zero sum, households react asymmetrically, mostly because borrowers are younger on average than lenders. As a result, inflation generates a decrease in labor supply as well as an increase in savings. Even though inflation-induced redistribution has a persistent negative effect on output, it improves the weighted welfare of domestic households.
    JEL: D31 D58 E31 E50
    Date: 2006–06
  11. By: N. Gregory Mankiw
    Abstract: This essay offers a brief history of macroeconomics, together with an evaluation of what has been learned over the past several decades. It is based on the premise that the field has evolved through the efforts of two types of macroeconomist— those who understand the field as a type of engineering and those who would like it to be more of a science. While the early macroeconomists were engineers trying to solve practical problems, macroeconomists have more recently focused on developing analytic tools and establishing theoretical principles. These tools and principles, however, have been slow to find their way into applications. As the field of macroeconomics has evolved, one recurrent theme is the interaction—sometimes productive and sometimes not— between the scientists and the engineers.
    Date: 2006–07
  12. By: Alberto Locarno (Banca d'Italia)
    Abstract: When the economy is subject to recurrent structural shifts, the monetary authority cannot credibly commit to a systematic approach to policy, since consistency between promises and actions is not easily verifiable; moreover, since agents have incomplete knowledge of the surrounding environment, they form expectations that may deviate substantially from the full-information case. The present paper studies the implications for the effectiveness of discretionary monetary policymaking of departing from the benchmark of rational expectations and assuming instead that agents learn adaptively. It focuses on two issues, namely whether imperfect knowledge generates a bias against stabilisation policies and whether the optimal monetary strategy takes the form of an inflation cap. Rules featuring an inflation cap are not only justified on theoretical grounds, but are also appealing because they seem appropriate to deal with imperfect knowledge and learning: by setting explicit bounds on inflation, they seem better suited to restrain expectations from drifting significantly away from target, thus removing one of the main sources of policy ineffectiveness. The main findings of the paper are the following. First, when agents do not possess complete knowledge on the structure of the economy and rely on an adaptive learning technology, a bias toward conservativeness arises. Second, a policy that involves a cap on inflation is helpful in reducing output and inflation variability, but it is not uniformly superior to a strategy aimed at minimising a quadratic loss function. Third, the bias against stabilisation policies and towards conservativeness does not depend on whether agents have finite or infinite memory.
    Keywords: Adaptive learning, optimal degree of monetary policy discretion, bias against activist policies
    JEL: E52 E31 D84
    Date: 2006–05
  13. By: Roc Armenter; Martin Bodenstein
    Abstract: We provide a tractable model to study monetary policy under discretion. We focus on Markov equilibria. For all parametrizations with an equilibrium inflation rate around 2%, there is a second equilibrium with an inflation rate just above 10%. Thus the model can simultaneously account for the low and high inflation episodes in the U.S. We carefully characterize the set of Markov equilibria along the parameter space and find our results to be robust.
    Keywords: Inflation (Finance) ; Econometric models ; Equilibrium (Economics) ; Monetary policy
    Date: 2006
  14. By: Kristoffer Nimark (Reserve Bank of Australia)
    Abstract: Monetary policy is conducted in an environment of uncertainty. This paper sets up a model where the central bank uses real-time data from the bond market together with standard macroeconomic indicators to estimate the current state of the economy more efficiently, while taking into account that its own actions influence what it observes. The timeliness of bond market data allows for quicker responses of monetary policy to disturbances compared to the case when the central bank has to rely solely on collected aggregate data. The information content of the term structure creates a link between the bond market and the macroeconomy that is novel to the literature. To quantify the importance of the bond market as a source of information, the model is estimated on data for the United States and Australia using Bayesian methods. The empirical exercise suggests that there is some information in the US term structure that helps the Federal Reserve to identify shocks to the economy on a timely basis. Australian bond prices seem to be less informative than their US counterparts, perhaps because Australia is a relatively small and open economy.
    Keywords: monetary policy; imperfect information; bond market; term structure of interest rates
    JEL: E32 E43 E52
    Date: 2006–06
  15. By: William Whitesell
    Abstract: Most central banks now implement monetary policy by trying to hit a target overnight interest rate using one of two types of frameworks. The first involves arrangements for depository institutions to hold a minimum account balance over a multi-day averaging period. The second uses the central bank's lending rate as a ceiling and its deposit rate as a floor for overnight interest rates. Either averaging or a rate corridor can help a central bank hit a target interest rate, but each framework can also have weaknesses in achieving that goal and, in some cases, other associated drawbacks. This paper discusses an alternative possible policy implementation regime, involving a specially designed facility for the payment of interest on a daily basis on balances held at the central bank. This new type of regime could potentially allow smooth monetary policy implementation without the problems associated with averaging or a rate corridor.
    Date: 2006
  16. By: Anna Piretti; Charles St-Arnaud
    Abstract: The authors develop a projection model of the euro area and the United Kingdom. The model consists of two country blocks, endogenous to each other via the foreign demand channel. Each country block features an aggregate IS curve, a forward-looking Phillips curve, and an estimated forward-looking monetary policy reaction function. Potential output is estimated by means of a Hodrick-Prescott filter, conditioned by an equilibrium path generated by a structural vector autoregression (Rennison 2003 and Gosselin and Lalonde 2002). The Phillips curve is specified in terms of the output gap, and inflation dynamics are described by the polynomial adjustment cost (PAC) approach, as in Kozicki and Tinsley (2002). The model delivers relatively accurate projections at a variety of forecast horizons and provides a useful tool for policy analysis. The authors’ simulation results suggest that output and inflation exhibit a greater degree of persistence to shocks in the euro area than in the United Kingdom.
    Keywords: Economic models; Business fluctuations and cycles
    JEL: C53 E17 E37
    Date: 2006
  17. By: Michal Horvath
    Abstract: Several papers have recently argued that price stickiness implies non-stationarity in models of monetary-fiscal interactions. The policy implication is that policy makers should allow a permanent drift in variables such as public debt or the tax rate in response to shocks. At the same time, a growing volume of literature advocates formulating optimal policies by minimizing expected welfare losses over unconditional rather than conditional expectations. We demonstrate that policies that maximize the unconditional expectation of the welfare objective in a forward-looking linear-quadratic framework necessarily imply mean reversion for all policy-relevant endogenous variables. This has important practical and theoretical implications.
    Keywords: Optimal monetary and fiscal policy, timeless perspective, unconditional expectation, time consistency.
    JEL: C61 E52 E61 E63
    Date: 2006–06
  18. By: Marcela Meirelles Aurelio
    Abstract: This paper identifies optimal policy rules in the presence of explicit targets for both the inflation rate and public debt. This issue is investigated in the context of a dynamic stochastic general equilibrium model that describes a small open economy with capital accumulation, distortionary taxation and nominal price rigidities. The model is solved using a second-order approximation to the equilibrium conditions. Optimal policy features a strong anti-inflation stance and strict fiscal discipline. Targeting a domestic inflation index - as opposed to CPI - improves welfare because it reduces the inefficiencies that stem from both price stickiness and income taxes.
    Keywords: Inflation (Finance) ; Prices ; Fiscal policy
    Date: 2006
  19. By: Francesca Lotti (Banca d'Italia); Juri Marcucci (Banca d'Italia)
    Abstract: In this paper we estimate the demand for liquidity by US non financial firms using data from COMPUSTAT database. In contrast to the previous literature, we consider firm-specific effects, such as cost-of-capital and wages. From the balanced and unbalanced panel estimations we infer that there are economies of scale in money demand by US business firms, because estimated sales elasticities are smaller than unity. In particular, they are lower than in previous empirical studies, suggesting that economies of scale in the demand for money are even bigger than formerly thought. In addition, it emerges that labor is not a substitute for money.
    Keywords: Panel Data, Liquidity, Demand for Money, COMPUSTAT
    JEL: E41 L60 C23
    Date: 2006–05
  20. By: Julien Matheron (Banque de France, DGEI-DIR-RECFIN); Céline Poilly (THEMA, Department of Economics, Cergy-Pontoise University; Banque de France, DGEI-DIR-RECFIN)
    Abstract: In this paper, we ask whether a small structural model with sticky prices and wages, embedding various modelling devices designed to increase the degree of strategic complementarity between price-setters, can fit postwar US data. To answer this question, we resort to a two-step empirical evaluation of our model. In a first step, we estimate the model by minimizing the distance between theoretical autocovariances of key macroeconomic variables and their VAR-based empirical counterparts. In a second step, we resort to Watson's (1993) test [Measures of fit for calibrated models. Journal of Political Economy 101 (6), 1011--1041] to quantify the model's goodness-of-fit. Our main result is that the combination of sticky prices and sticky wages is central in order to obtain a good empirical fit. Our analysis also reveals that a model with only sticky wages is completely rejected by Watson's test while a model with only sticky prices is not overwhelmingly rejected.
    Keywords: Sticky prices, sticky wages, strategic complementarities, Watson's test
    JEL: C52 E31 E32
    Date: 2006–04
  21. By: Francisco Ledesma-Rodríguez; Manuel Navarro-Ibáñez; Jorge Pérez-Rodríguez; Simón Sosvilla-Rivero
    Abstract: This paper attempts to identify implicit exchange rate regimes for the Yen/Dollar exchange rate. To that end, we apply a sequential procedure that considers both the dynamics of exchange rates and central bank interventions to data covering the period from 1971 to 2003. Our results would suggest that implicit bands existed in two subperiods: April-December 1980 and March-December 1987, the latter coinciding with the Louvre Accord. Furthermore, the study of the credibility of such implicit bands indicates the high degree of confidence attributed by economic agents to the evolution of the Yen/Dollar exchange rate within the detected implicit band rate, thus lending further support to the relevance of such implicit bands.
  22. By: Adam Hale Shapiro
    Abstract: It has become customary to estimate the New Keynesian Phillips Curve (NKPC) with GMM using a large instrument set that includes lags of variables that are ad hoc to the model. Researchers have also conventionally used real unit labor cost (RULC) as the proxy for real marginal cost, even though it is difficult to support its significance. This paper introduces a new proxy for the real marginal cost term as well as a new instrument set, both of which are based on the micro foundations of the vertical chain of production. I find that the new proxy, based on input prices as opposed to wages, provides a more robust and significant fit to the model. Instruments that are based on the vertical chain of production appear to be both more valid and relevant towards the model.
    Keywords: Phillips curve ; Keynesian economics
    Date: 2006
  23. By: Todd E. Clark; Michael W. McCracken
    Abstract: Small-scale VARs have come to be widely used in macroeconomics, for purposes ranging from forecasting output, prices, and interest rates to modeling expectations formation in theoretical models. However, a body of recent work suggests such VAR models may be prone to instabilities. In the face of such instabilities, a variety of estimation or forecasting methods might be used to improve the accuracy of forecasts from a VAR. These methods include using different approaches to lag selection, observation windows for estimation, (over-) differencing, intercept correction, stochastically time--varying parameters, break dating, discounted least squares, Bayesian shrinkage, detrending of inflation and interest rates, and model averaging. Focusing on simple models of U.S. output, prices, and interest rates, this paper compares the effectiveness of such methods. Our goal is to identify those approaches that, in real time, yield the most accurate forecasts of these variables. We use forecasts from simple univariate time series models, the Survey of Professional Forecasters and the Federal Reserve Board's Greenbook as benchmarks.
    Keywords: Economic forecasting ; Time-series analysis
    Date: 2006
  24. By: Mark Aguiar; Manuel Amador; Gita Gopinath
    Abstract: We study a small open economy characterized by two empirically important frictions— incomplete financial markets and an inability of the government to commit to policy. We characterize the best sustainable fiscal policy and show that it can amplify and prolong shocks to output. In particular, even when the government is completely benevolent, the government’s credibility not to expropriate capital varies endogenously with the state of the economy and may be “scarcest” during recessions. This increased threat of expropriation depresses investment, prolonging downturns. It is the incompleteness of financial markets and the lack of commitment that generate investment cycles even in an environment where first-best capital stock is constant.
    Keywords: Fiscal policy
    Date: 2006
  25. By: Lawrence J. Christiano; Martin Eichenbaum; Robert Vigfusson
    Abstract: This paper analyzes the quality of VAR-based procedures for estimating the response of the economy to a shock. We focus on two key issues. First, do VAR-based confidence intervals accurately reflect the actual degree of sampling uncertainty associated with impulse response functions? Second, what is the size of bias relative to confidence intervals, and how do coverage rates of confidence intervals compare with their nominal size? We address these questions using data generated from a series of estimated dynamic, stochastic general equilibrium models. We organize most of our analysis around a particular question that has attracted a great deal of attention in the literature: How do hours worked respond to an identified shock? In all of our examples, as long as the variance in hours worked due to a given shock is above the remarkably low number of 1 percent, structural VARs perform well. This finding is true regardless of whether identification is based on short-run or long-run restrictions. Confidence intervals are wider in the case of long-run restrictions. Even so, long-run identified VARs can be useful for discriminating among competing economic models.
    JEL: C1
    Date: 2006–07
  26. By: Alessio Ciarlone (Bank of Italy); Giorgio Trebeschi (Bank of Italy)
    Abstract: This paper develops an early warning system for sovereign debt crises, broadly defined as episodes of outright default, failure of a country to be current on external obligations and substantial access to IMF resources. It estimates a multinomial logit model that makes it possible to differentiate between three regimes labelled ‘tranquil’, ‘pre-crisis’ and ‘adjustment’. The model includes a large set of macroeconomic variables and is able to predict, in-sample, 78 per cent of onsets of crisis while sending false alarms in 34 per cent of tranquil cases; its out-of-sample performance is very similar, with 70 per cent of entries into crisis correctly predicted and 20 per cent of tranquil cases triggering false alarms.
    Keywords: emerging markets, early warning systems, debt crises, default
    JEL: H63 E66
    Date: 2006–05
  27. By: Tressel, Thierry; Detragiache, Enrica; Demirguc-Kunt, Asli
    Abstract: This paper studies whether compliance with the Basel Core Principles for Effective Banking Supervision (BCP) improves bank soundness. BCP compliance assessments provide a unique source of information about the quality of bank supervision and regulation around the world. The authors find a significant and positive relationship between bank soundness (measured with Moody ' s financial strength ratings) and compliance with principles related to information provision. Specifically, countries that require banks to report regularly and accurately their financial data to regulators and market participants have sounder banks. This relationship is robust to controlling for broad indexes of institutional quality, macroeconomic variables, sovereign ratings, as well as reverse causality. Measuring soundness through z-scores yields similar results. The findings emphasize the importance of transparency in making supervisory processes effective and strengthening market discipline. Countries aiming to upgrade banking regulation and supervision should consider giving priority to information provision over other elements of the Core Principles.
    Keywords: Banks & Banking Reform,Financial Intermediation,Corporate Law,Financial Crisis Management & Restructuring,Insurance & Risk Mitigation
    Date: 2006–06–01
  28. By: Jaime Marquez; John W. Schindler
    Abstract: Though China's share of world trade is comparable to that of Japan, little is known about the response of China's trade to changes in exchange rates. The few estimates available suffer from two limitations. First, the data for trade prices are based on proxies for prices from other countries. Second, the estimation sample includes the period of China's transformation from a centrally-planned economy to a market-oriented system. To address these limitations, this paper develops an empirical model explaining the shares of China's exports and imports in world trade in terms of the real effective value of the renminbi. The specifications control for foreign direct investment and for the role of imports of parts to assemble merchandise exports. Parameter estimation uses disaggregated monthly trade data and excludes the period during which most of China's decentralization occurred. The estimation results suggest that a ten-percent real appreciation of the renminbi lowers the share of aggregate Chinese exports by a half of a percentage point. The same appreciation lowers the share of aggregate imports by about a tenth of a percentage point.
    Keywords: Foreign exchange rates - China ; Trade ; Econometric models
    Date: 2006
  29. By: Kuijs, Louis
    Abstract: This paper investigates how China ' s saving, investment, and saving-investment balance will evolve in the decades ahead. Household saving in China is relatively high compared with OECD countries. However, much of China ' s high economywide saving, and the difference between China and other countries, are due to unusually high enterprise and government saving. Moreover, cross-country empirical analysis shows that economywide saving and investment in China are higher than what would be expected, even adjusting for differences in economic structure. Combined, these findings suggest that much of China ' s high saving is the result of policies particular to China. Looking ahead, the econometric results suggest that purely on the basis of projected structural developments-including development, changes in economic structure, urbanization, and demographics-saving and investment would both decline only mildly in the coming two decades, with ambiguous impact on the current account surplus. However, the potential effect on saving, investment, and the saving-investment balance of several policy adjustments could be large. Several of these policies are identified and their likely impact assessed and quantified. This exercise suggests that rebalancing along these lines should reduce both saving and the current account surplus over time, although the surplus is unlikely to turn into a deficit soon.
    Keywords: Economic Theory & Research,Investment and Investment Climate,Economic Investment & Savings,Non Bank Financial Institutions,Contractual Savings
    Date: 2006–07–01
  30. By: Gene M. Grossman; Elhanan Helpman
    Abstract: We study budget formation in a model featuring separation of powers. In our model, the legislature designs a budget bill that can include a cap on total spending and earmarked allocations to designated public projects. Each project provides random benefits to one of many interest groups. The legislature can delegate spending decisions to the executive, who can observe the productivity of all projects before choosing which to fund. However, the ruling coalition in the legislature and the executive serve different constituencies, so their interests are not perfectly aligned. We consider settings that differ in terms of the breadth and overlap in the constituencies of the two branches, and associate these with the political systems and circumstances under which they most naturally arise. Earmarks are more likely to occur when the executive serves broad interests, while a binding budget cap arises when the executive’s constituency is more narrow than that of the powerful legislators.
    JEL: H61 D78 H41
    Date: 2006–06
  31. By: Laurence J. Kotlikoff; Jerry Green
    Abstract: A century ago, everyone thought time and distance were well defined physical concepts. But neither proved absolute. Instead, measures/reports of time and distance were found to depend on one’s reference point, specifically one’s direction and speed of travel, making our apparent physical reality, in Einstein’s words, “merely an illusion.” Like time and distance, standard fiscal measures, including deficits, taxes, and transfer payments, depend on one’s reference point/reporting procedure/language/labels. As such, they too represent numbers in search of concepts that provide the illusion of meaning where none exists. This paper, dedicated to our dear friend, David Bradford, provides a general proof that standard and routinely used fiscal measures, including the deficit, taxes, and transfer payments, are economically ill-defined. Instead these measures reflect the arbitrary labeling of underlying fiscal conditions. Analyses based on these and derivative measures, such as disposable income, private assets, and personal saving, represent exercises in linguistics, not economics.
    JEL: H3 H6
    Date: 2006–06
  32. By: Adalbert Winkler (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany); Roland Beck (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany)
    Abstract: This paper – based on a report by a Task Force established by the International Relations Committee (IRC) of the European System of Central Banks (ESCB) – reviews macroeconomic and financial stability challenges for acceding (Bulgaria and Romania) and candidate countries (Croatia and Turkey). In an environment characterised by strong growth and capital inflows, the main macroeconomic challenges relate to the recent pick-up of inflation and the large and widening current account deficits. Moreover, rapid credit growth has been a recent feature of financial development in all countries and thus constitutes the main financial stability challenge. In general, monetary authorities have responded to these challenges by tightening monetary conditions and prudential standards, with concrete measures also reflecting the different monetary and exchange rate regimes in the region. The paper also highlights four specific features of financial development in the countries under review, namely the dominance of banks in financial intermediation, the strong participation of foreign-owned banks, the widespread use of foreign currencies and the strengthening of supervisory frameworks. JEL Classification: E65, G21, G38, O16, P27.
    Keywords: South-East Europe, macroeconomic performance, credit growth, financial stability.
    Date: 2006–07
  33. By: Baldwin, John R.; Yan, Beiling
    Abstract: Durant la période qui a suivi 1970, les prix dans le secteur canadien de la fabrication ont tour à tour augmenté et diminué par rapport aux prix américains, chaque fois à l'inverse des mouvements du taux de change Canada États Unis. Cependant, toutes les industries manufacturières n'ont pas connu une variation des prix relatifs de même ampleur. Dans la présente étude, nous examinons les caractéristiques des industries qui sont liées à l'évolution sur le plan de la compétitivité, mesurée comme étant le rapport relatif des prix canadiens et des prix américains corrigés par le taux de change. Nous constatons que les coûts des facteurs de production relatifs et la croissance de la productivité relative sont les deux facteurs les plus importants qui influent sur les variations des prix relatifs au Canada et aux États Unis. Les pressions concurrentielles émanant des échanges sont des déterminants importants de la mesure dans laquelle les différences de productivité relative se répercutent sur les prix relatifs dans les secteurs de la fabrication des deux pays. Nous constatons également que l'ampleur de la concurrence sur le marché intérieur et l'intensité des exportations influent sur les variations des prix relatifs à court terme au cours du cycle du taux de change.
    Keywords: Commerce, Prix et indices des prix, Fabrication, Commerce international, Prix, Industries manufacturières
    Date: 2006–06–28
  34. By: Baldwin, John R.; Yan, Beiling
    Abstract: During the post-1970 period, Canadian manufacturing prices have alternately increased and fallen relative to U.S. prices' just the reverse of the cycle in the Canada' U.S. exchange rate. But not all manufacturing industries have experienced the same amplitude of relative price changes. This paper examines the industry characteristics that are related to the shifts in competitiveness, measured as the relative price ratio between Canadian prices and U.S. prices adjusted by the exchange rate. We find that relative factor input costs and relative productivity growth are the two most important factors influencing changes in relative Canada' U.S. prices. Competitive pressures emanating from trade are important determinants of the extent to which relative productivity differences are passed through to cross-country relative prices in the manufacturing sector. We also find that the magnitude of domestic market competition and export intensity affects the short-run relative price shifts over the cycle of exchange rate.
    Keywords: Trade, Prices and price indexes, Manufacturing, International trade, Prices, Manufacturing industries
    Date: 2006–06–28
  35. By: Jaakko Kiander; Antti Romppanen
    Abstract: This paper summarizes the economic performance of Finland in 1995?2004 and compares the actual developments to the projections made prior to the EU membership. The paper also assesses the impacts of the structural changes induced by the membership. The most pronounced impact of EU membership was on Finland?s agriculture and food industry. Joining the Common Agriculture meant a total change in the subsidy system and a sharp drop in producer prices. At the same time, agriculture and the food industry became part of the European internal market and the competition that goes with it. In sectors outside of the food chain, the impact of the EU is more difficult to ascertain. It was thought that integration would lead to increased trade in the internal market area. But this has not happened; rather the EU?s share of Finland?s foreign trade has decreased since membership.
    Keywords: Finnish economy, EU membership, integration
    Date: 2006–01–13
  36. By: Pekka Sulamaa; Mika Widgrén
    Abstract: This paper examines the economic effects of the opening of the Russian Federation. The analysis carried out in the paper is two-fold. First we simulate the impact of the eastern enlargement of the EU and, second, we analyse how deeper integration between the EU and Russia contributes to this. The analysis is carried out with GTAP computable general equilibrium model. We find that there is a trade-off between the two roads of European integration arrangements. Eastern enlargement seems, even in its very deep form, be beneficial for all EU regions without causing substantial welfare losses outside the Union. EU-Russia integration, on the other hand, has different impact. To be beneficial for Russia free trade between the EU and Russia requires improved productivity in the latter, which may be due to better institutions or increased FDI. This might make the negotiations of the agreement cumbersome and if agreed its implementation difficult.
    Keywords: Integration, Free Trade Agreement, GTAP, EU, Russia
    Date: 2004–12–16
  37. By: Eduardo Levy Yeyati
    Abstract: Unlike the financial dollarization (FD) of external liabilities, the dollarization of domestic financial assets (domestic FD) has received comparatively less attention until very recently, when it has been increasingly seen as a key source of balance sheet exposure. This paper focuses on a complementary –and often overlooked– angle of domestic FD: the limit it imposes on the central bank as domestic lender of last resort, and the resulting exposure to dollar liquidity runs. The paper discusses the incidence of FD on banking crisis propensity, shows that FD has been an important motive for self insurance in the form of international reserves, and highlights the moral hazard associated with centralized reserve accumulation. Next, it illustrates the authorities’ belated recourse to suspension of convertibility in two recent banking crises (Argentina 2001 and Uruguay 2002). Finally, it argues for a combined scheme of decentralized reserves (liquid asset requirements on individual banks) to limit moral hazard, and an ex-ante suspension-of-convertibility clause (“circuit breakers”) to reduce self-insurance costs while limiting bank losses in the event of a run.
    JEL: G2 F3
    Date: 2006–06
  38. By: Leonard I. Nakamura
    Abstract: This article presents a brief overview of the national income accounts. It summarizes the main parts of accounts and situates them within the efforts of economists to quantify economic activity and economic well-being. The author argues that these statistics are necessarily provisional and imperfect but nevertheless extremely useful. Some current directions for economic research seeking to extend the accounts are also discussed.
    Keywords: National income
    Date: 2006
  39. By: Gary S. Anderson
    Abstract: This paper compares the functionality, accuracy, computational efficiency, and practicalities of alternative approaches to solving linear rational expectations models, including the procedures of (Sims, 1996), (Anderson and Moore, 1983), (Binder and Pesaran, 1994), (King and Watson, 1998), (Klein, 1999), and (Uhlig, 1999). While all six prcedures yield similar results for models with a unique stationary solution, the AIM algorithm of (Anderson and Moore, 1983) provides the highest accuracy; furthermore, this procedure exhibits significant gains in computational efficiency for larger-scale models.
    Date: 2006
  40. By: Yongsung Chang; Andreas Hornstein
    Abstract: Studying the incentives and constraints in the non-market sector — that is, home production — enhances our understanding of economic behavior in the market. In particular, it helps us to understand (1) small variations of labor supply over the life cycle, (2) large variations of employment relative to wages over the business cycle, and (3) large income differences across countries.
    Keywords: Labor supply
    Date: 2006

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